Upload
others
View
0
Download
0
Embed Size (px)
Citation preview
Open Economy MacroeconomicsExchange Rates, Interest Rates and Macroeconomic Policy
Elements of Macroeconomics ▪ Johns Hopkins University
Outline
1. Exchange Rates
2. Theories: Purchasing Power Parity and Uncovered Interest Parity
3. Monetary and Fiscal Policy in Open Economies
• Textbook Readings: Ch. 18 & Ch. 19 pp. 676-681
Elements of Macroeconomics ▪ Johns Hopkins University
How Economies Are Connected?
• Goods flow between nations§ USA sends corn to China§ China sends flat screen TVs to USA
• Services flow between nations§ USA processes European transactions via Mastercard§ India fields questions on iPad usage via call centers
• Financial assets flow between nations§ China’s central bank (PBoC) has bought billions of U.S. Treasuries§ U.S. companies invest billions of dollars building factories in China
Elements of Macroeconomics ▪ Johns Hopkins University
Balance of Payments
• Records all transactions with foreign economic agents over a period of time (a flow)
• 3 main types of transactions:§ Exports and imports of G&S ➞ CA: Current Account§ Sale and purchase of financial assets ➞ FA: Financial Account§ Certain transfers of wealth (small) ➞ KA: Capital Account
• Balance of payments (BoP) has to balance:BoP = CA + FA + KA = 0
Elements of Macroeconomics ▪ Johns Hopkins University
Why Does the BoP Has to Balance?
• CA captures transactions of G&S ➞ Think EX – IM§ Related to NX (or the trade balance), but is not exactly the same§ Recall how do we go from GDP to GNP?§ NFIA (Net Factor Income from Abroad) = FP from ROW – FP to ROW§ To obtain GNP, we add NFIA to GDP§ CA = NX + NFIA
• FA captures how that is financed ➞ Think Inflows – Outflows§ A measure of international lending and borrowing§ International financial flows
Elements of Macroeconomics ▪ Johns Hopkins University
Why Does the BoP Has to Balance? Example
• US people buy $475b worth of Chinese goods every year
• Chinese people buy $115b worth of US goods every year
•What does China do with the rest $360b?
• China receives $360b of US assets § PBoC buys T-bonds, § Chinese elites buy US stocks and Seattle real state
Elements of Macroeconomics ▪ Johns Hopkins University
CA Deficit/Surplus ➞ FA Surplus/Deficit
• A CA deficit must be offset by an FA surplus (e.g. US)§ In September 2017, US bought $43b more G&S than sold to ROW
§ Therefore, ROW purchases of US assets must have been $43b higher than US purchases of ROW assets
v US invests in factories in China and buys European stocks
v ROW buys US Treasuries, shares of US companies, houses in Florida
• A CA surplus must be offset by an FA deficit (e.g. China)
Elements of Macroeconomics ▪ Johns Hopkins University
Saving and Investment in an Open Economy
• In a closed economy, we saw that:
S = I
• In an open economy we have (CA identity):
CA = S – I or I = S - CA
•What does the CA identity say?
Elements of Macroeconomics ▪ Johns Hopkins University
Net Foreign Asset Position
• BoP records a flow (not a stock)
• Net foreign asset (NFA) position is a stock§ Value of US-owned foreign assets - Value of foreign-owned US assets§ Also called Net International Investment (NII) position or External Wealth§ A CA deficit reduces NFA position and vice versa§ NFA < 0 ➞ Debtor country
• US is a net debtor to the world, China is a net lender to the world
Elements of Macroeconomics ▪ Johns Hopkins University
The World is Much More “Inter-Owned”
• US consistently has CA deficits ➞ Net debtor position has grown• However, US also owns a large sum of ROW assets• Net debtor position is small relative to gross assets and liabilities
§ Surge in gross flows
Elements of Macroeconomics ▪ Johns Hopkins University
U.S. As A Net Debtor
Elements of Macroeconomics ▪ Johns Hopkins University
NFA Position: Return on Assets
• Despite the US net debtor status, it collects more on its assets than what it pays on its liabilities§ Income received in US investments abroad:
$783bn in 2015 on $25tr ➞ US Return of Assets: 3.1%§ Income paid to foreign-owned US assets:
$600.5b in 2015 on $33tr ➞ ROW Return of Assets: 1.8%
•Why does the US have a much better ROA?§ US owns factories around the world§ Foreigners own US Treasury securities
Elements of Macroeconomics ▪ Johns Hopkins University
Exchange Rates
•When selling a good, a service or a financial asset, foreigners will often want to be paid in their own currency
• Nominal exchange rate: Value of one currency in terms of another
• Important because they affect relative prices in different markets:§ Labor ➞ Employment§ Goods ➞ International trade§ Financial assets ➞ International finance
Elements of Macroeconomics ▪ Johns Hopkins University
Notation
• Exchange rates can be expressed in two ways§ Example: If one US dollar can purchase 100 Japanese yen, then the
exchange rate is ¥100 = $1; or alternatively ¥1 = $0.01
• Our notation: E¥/$ = 100 or E$/¥ = 0.01
•Warning: Convention in the market uses the opposite notation§ Example: Our E¥/$ is quoted as EUSDJPY in the market
Elements of Macroeconomics ▪ Johns Hopkins University
Exchange Rate Quotations
Elements of Macroeconomics ▪ Johns Hopkins University
August 14, 2015
Currency(XYZ)
Units of Foreign Currency per USD
(How many XYZ can be purchased with $1 or how many XYZ are
needed to buy $1)
USD per Unit of Foreign Currency
(How many dollars can be purchased with 1 XYZ or how many
dollars are needed to buy 1 XYZ)
Japanese yen 124.32 0.008Chinese renminbi (or yuan) 6.39 0.156British pound 0.64 1.56Euro (used by 19 countries) 0.90 1.11
Using Exchange Rates
• Assume the value of euros in terms of dollars is E$/€ = 1.25
• A foreigner has €40, how many dollars can she buy?€40 x E$/€ = €40 x 1.25 = $50
• If you have $65, how many euros can you buy?
$65 x !"$/€
= $65 x E€/$ = $65 x 0.8 = €52
• If you want to buy €100, how many dollars do you need?$?? x 0.8 = €100 ➞ $125
Elements of Macroeconomics ▪ Johns Hopkins University
Exchange Rates: Volatile Relative Prices of Currencies
Elements of Macroeconomics ▪ Johns Hopkins University
Appreciation and Depreciation
• Currency appreciates when it increases in value relative to another• Currency depreciates when it decreases in value relative to another• Sometimes ‘stronger’ and ‘weaker’ is used but may be misleading
• Example: § If the exchange rate changes from ¥ 100 = $1 to ¥ 120 = $1, which
currency appreciated?
§ If the exchange rate changes from ¥ 1 = $ 0.010 to ¥ 1 = $ 0.015, which currency depreciated?
Elements of Macroeconomics ▪ Johns Hopkins University
What Happen to the US Dollar 2001-2008?
Elements of Macroeconomics ▪ Johns Hopkins University
Is a Strong Dollar Better than a Weak Dollar?
• The words “strong” and “weak” can mislead people to believe that an appreciating currency is always better for the economy
• There is no simple connection between the strength of a country’s currency and the strength of its economy
• Swings in exchange rates create both winners and losers
Elements of Macroeconomics ▪ Johns Hopkins University
With a depreciation of the dollar
EX are cheaperIM are expensive 𝑁𝑋 ↑
With an appreciation of the dollar
EX are expensiveIM are cheaper 𝑁𝑋 ↓
The Market for Euros
•We can think about exchange rates using supply/demand curves• The market for euros is just like any other market
Elements of Macroeconomics ▪ Johns Hopkins University
Downward Sloping Demand for Currency
• 1972-1980 surge in oil prices§Sharp reduction in
demand
• 1980-1984 price of European currencies plunged§ Surge in buying of those
currencies§ Facilitated buying of European
goods by US citizens
Elements of Macroeconomics ▪ Johns Hopkins University
Upward Sloping Supply for Currency
• If oil price leaps (e.g. $100), output soars
• If the price of the euro soars, it means that you get more dollars per euro
§ The purchasing power of the € jumps
§ You swap your euros for dollars to buy cheap US goods
Elements of Macroeconomics ▪ Johns Hopkins University
Equilibrium in the Market for Euros
•Market exchange rate is determined by the interaction of demand and supply
Elements of Macroeconomics ▪ Johns Hopkins University
Forex Markets
Elements of Macroeconomics ▪ Johns Hopkins University
Have (sell) $, want (buy) ¥
Have (sell) ¥, want (buy) $
Dolla
r dep
reci
ates
Have (sell) ¥, want (buy) $
Have (sell) $, want (buy) ¥
Dolla
r app
reci
ates
Market for Dollars Market for Yen
Supply and Demand in Forex: Two Sides of Same Coin
Elements of Macroeconomics ▪ Johns Hopkins University
Forex Markets
• Demand curve in USD market equals supply curve in Yen market
Elements of Macroeconomics ▪ Johns Hopkins University
Who Demands a Currency?
• Demand for dollars (= Supply of yen) composed by:§ Foreign firms and HH that want to buy G&S produced in the US
§ Foreign firms and HH that want to buy financial assets issued in the US
§ Currency traders: If they believe that the value of the $ in the future (¥140) will be greater than its value today (¥120), they will buy dollars
Example: Sell ¥120M in t ➞ Buy $1M in t ➞ Buy ¥140M in t+1
• Similar for the demand for yen (= Supply of dollar)
Elements of Macroeconomics ▪ Johns Hopkins University
Shifts of Curves in Forex Market
• Shifts in demand and supply curves cause the equilibrium exchange rate to change
• 3 main factors cause the curves in the forex market to change:§ Changes in demand for US-produced G&S vs foreign-produced G&S
§ Changes in desire to buy US financial assets vs foreign financial assets
§ Changes in expectations of currency traders about the likely future value of currencies
Elements of Macroeconomics ▪ Johns Hopkins University
Example: Shifts in Demand for $ (= Supply of ¥)
• Demand for $ (= Supply of ¥) shift to the
• Similar for shifts in the demand for ¥ (= supply of $)Elements of Macroeconomics ▪ Johns Hopkins University
Right when:• Expansion in Japan, • Interest rates in the US rise, or • Speculators expect the future
value of the dollar to be higher than its current value
Left when:• Recession in Japan, • Interest rates in the US fall, or • Speculators expect the future
value of the dollar to be lower than its current value
Shifts in Demand and Supply in Forex Market
• There can be shifts in both the demand and supply curves for one currency
•Whether the exchange rate increases or decreases depends on the direction and size of the shifts in both curves
Elements of Macroeconomics ▪ Johns Hopkins University
Example: Boom in the US
• Effect 1: US demand goes up for all goods, including Japanese goods ➞ Increased demand for ¥
Elements of Macroeconomics ▪ Johns Hopkins University
Example: Boom in the US
• Effect 2: With strong US economy, US interest rates will rise and so Japanese demand for US assets ➞ Increased demand for $
Elements of Macroeconomics ▪ Johns Hopkins University
Exchange Rate Regimes
• Exchange rate regimes: How countries manage their exchange rates
• Two general categories:§ Fixed exchange-rate regimes§ Floating exchange-rate regimes
• Some countries fix their exchange rates
Elements of Macroeconomics ▪ Johns Hopkins University
Central Bank’s Role in the Forex Market
•With a closed economy perspective, we said central banks focus on one of two targets§ Target the money supply and use the quantity equation§ Target an interest rate, think in a loanable funds model and use Taylor rule
• In an open economy, CBs can use monetary policy to guide their exchange rate§ Example: China kept the renminbi at RM8.3/$ for 10 years
Elements of Macroeconomics ▪ Johns Hopkins University
RM/$ Exchange Rate
Elements of Macroeconomics ▪ Johns Hopkins University
US-China Trade and Exchange Rate
• US bought zillion TVs and PBoC bought trillions of T-bonds
• US demand for China’s goods soared§ 1995-2005: US trade deficit with China climbed from $20bn to $200bn
• US demand for Chinese renminbi soared§ Value of renminbi vs $ should have soared § A dime for a RM (0.12$/RM = 8.3RM/$) in 1995 could have been a
quarter for a RM in 2005
• How did the RM stay steady vs $ while the US trade deficit with China soared?
Elements of Macroeconomics ▪ Johns Hopkins University
Monetary Policy and Exchange Rates
Elements of Macroeconomics ▪ Johns Hopkins University
What Did the PBoC Did with All Those Dollars?
Elements of Macroeconomics ▪ Johns Hopkins University
Real Exchange Rate
• Relative prices of two countries’ G&S are determined by:§ Relative price levels in the two countries§ Nominal exchange rate between the two countries’ currencies
• These two factors are combined to obtain the real exchange rate
• Real exchange rate (RER): Price of domestic goods in terms of foreign goods
Elements of Macroeconomics ▪ Johns Hopkins University
Real Exchange Rate: Formula
• RER corrects the nominal exchange rate for differences in prices of G&S between countries§ Useful to evaluate real change in value of a currency’s purchasing power
• Definition:q = E x (P€/P$)
qUS/EU – real exchange rateE$/€ – nominal exchange rateP€ – average price level in the euro areaP$ – average price level in the US
Elements of Macroeconomics ▪ Johns Hopkins University
Real Exchange Rate: Example
• Assume you need €100 to buy a broad basket of G&S in euro area
• Assume that if you exchange your €100 for $, you can buy 25% more of the same basket of G&S in the US
• Then the RER between the US and the Eurozone isqUS/EU = 1.25
• RER says how many units of the basket you can buy in the US per unit of basket in the euro area § qUS/EU > 1 ➞ G&S are more expensive in the Eurozone than in the US
Elements of Macroeconomics ▪ Johns Hopkins University
Nominal vs Real Exchange Rate
• Difference between nominal and real exchange rate?
• Real exchange rate, q, is the relative price of (baskets of) goods
• Nominal exchange rate, E, is the relative price of currencies
Elements of Macroeconomics ▪ Johns Hopkins University
Effective Exchange Rate
• An exchange rate is between two currencies•We can create an index (weighted by trade) to see whether a
currency appreciates or depreciates against many currencies
Elements of Macroeconomics ▪ Johns Hopkins University
Purchasing Power Parity Theory
• Purchasing Power Parity (PPP) : In the long run, goods should have about the same price everywhere when expressed in terms of a given currency
• Implication for nominal exchange rates?
§ What nominal exchange rate allows the two currencies to have the same purchasing power
Elements of Macroeconomics ▪ Johns Hopkins University
Purchasing Power Parity Theory
• Example:§ In country A, I spend $130,000 per year in house, car, food, drinks§ In country B, I spend €100,000 per year in house, car, food, drinks§ What nominal exchange rate gives me the same purchasing power?
• PPP implies q = 11 = E x (P€/P$)
E$/€ = P$/P€
Elements of Macroeconomics ▪ Johns Hopkins University
The Big Mac Index
• The Economist magazine compares Big Mac prices across countries•We compare hamburger prices and infer the currency value that
makes them equal
•What RM/$ exchange rate equalizes the cost of a burger?ERM/$ = RM19.3/$5.3 = RM3.64/$Elements of Macroeconomics ▪ Johns Hopkins University
Price of a Big MacLocal Currency Price (as of 7/17)
US $5.30China RM19.30
Undervalued and Overvalued Currencies
• According to the Big Mac index, ERM/$ should be RM3.64 = 1$
• If the current market exchange rate were RM6.6 = $1, what does the Big Mac index say about the RM? § Is it undervalued or overvalued?
• To go from RM6.6 = $1 to RM3.64 = 1$, RM would need to appreciate ➞ Today’s value (RM6.6 = $1) is undervalued relative to RM3.64 = 1$
Elements of Macroeconomics ▪ Johns Hopkins University
PPP: Application
• IMF provides a summary table of economic performances
Elements of Macroeconomics ▪ Johns Hopkins University
Application
• From table: China $19 tr vs US $16.7 tr• China’s economy uses yuan or renminbi, how did we get Chinese
GDP in US dollars?•What is the 2016 value for Chinese real GDP in renminbi?
§ RM66.5 tr•What if we use the nominal (forex market) exchange rate RM/$ to
convert China’s real GDP from RM into $?
𝑅𝑀66.5 𝑡𝑟 ×$1
𝑅𝑀6.6= $𝟏𝟎 𝒕𝒓
Elements of Macroeconomics ▪ Johns Hopkins University
Application
•Why does the IMF don’t use market exchange rates?§ Not be the best guide to equate countries’ real GDP levels§ IMF evaluates purchasing power of currencies§ IMF looks at the prices of thousands of G&S to calculate PPP
• Instead of using market exchange rates, we can use the implied PPP exchange rate obtained using the Big Mac index
𝑅𝑀66.5 𝑡𝑟 ×$1
𝑅𝑀3.4= $𝟏𝟖. 𝟑 𝒕𝒓
• The PPP-adjusted exchange rate gets us close to the $19 trElements of Macroeconomics ▪ Johns Hopkins University
Is PPP Supported in the Data?
• In practice, PPP does not hold exactly§ Not all products can be traded internationally§ Products and consumer preferences are different across countries§ There are barriers to trade
• PPP applies in the long run on average between countries that have a similar levels of development§ Example: US and UK§ However, deviations are relatively persistent
Elements of Macroeconomics ▪ Johns Hopkins University
Exchange Rates and Interest Rates
•What is the relationship between interest rates and the exchange rate?
• Bonds denominated in different currencies yield different interest rates
• Arbitrage: All bonds should have the same expected dollar return§ Interest rate differential between bonds in two countries should equal
the expected change in the exchange rate
Elements of Macroeconomics ▪ Johns Hopkins University
International Bond Investment
• E$/€ - Current dollar per foreign currency (say euro) exchange rate• E’ - Exchange rate ($/€) in one year• i€ - Foreign interest rate for one year• i$ - Dollar interest rate for one year
• Let’s start with $1. You have two options to invest it:1. You can invest your $1 at the dollar interest rate i$2. You can invest it at the foreign interest rate i€ after you exchange your
dollar for foreign currency using E ➞ After receiving your interests, you exchange your money back into $ using E’
Elements of Macroeconomics ▪ Johns Hopkins University
Elements of Macroeconomics ▪ Johns Hopkins University
1 dollartoday
1/E eurotoday
(1+i€)/E euroin one year
(1+i €)E’/E dollarin one year
• If you invest in the foreign bond:
• If you invest in the US bond:
Elements of Macroeconomics ▪ Johns Hopkins University
1 dollartoday
(1 + 𝑖€)"?"
dollars in one year
1 dollartoday
(1 + 𝑖$) dollars in one year
Uncovered Interest Parity
• Global investors should expect foreign currency bonds to have approximately the same dollar return as dollar bonds§ What would happen otherwise?
• UIP says all bonds should have the same expected dollar return
1 + 𝑖$ = 1 + 𝑖€"@
"
Ee – Exchange rate expected in one year
• Uncovered because the exchange rate risk (E’ ≠ Ee) is not hedgedElements of Macroeconomics ▪ Johns Hopkins University
What Does UIP Say?
1 + 𝑖$ = 1 + 𝑖€"@
"
Elements of Macroeconomics ▪ Johns Hopkins University
Gross US deposit dollar return
Gross euro deposit (expected) dollar return
UIP: Approximate Formula
1 + 𝑖$ = 1 + 𝑖€𝐸𝑒
𝐸
𝑖$ ≈ 𝑖€ +Δ𝐸𝑒
𝐸
𝑖€ − 𝑖$ = −Δ𝐸𝑒
𝐸
Elements of Macroeconomics ▪ Johns Hopkins University
What Does the Approximate Formula Say?
𝑖€ − 𝑖$ = −Δ𝐸𝑒
𝐸
• Note: Since E = E$/€ , Ee ↓ means that € is expected to depreciate
• A foreign currency that is expected to depreciate must yield a higher interest rate than the dollar
• A foreign currency that yields a high interest rate is likely to depreciate§ The opposite would be too good to be true
Elements of Macroeconomics ▪ Johns Hopkins University
What Does the Data Say About UIP?
𝑖€ − 𝑖$ = −Δ𝐸𝑒
𝐸
• Implication: The interest rate differential should be a good predictor of currency depreciation against the dollar
• Approximately true for survey data on market expectations
• Not so good when use realized exchange rates
Elements of Macroeconomics ▪ Johns Hopkins University
Comparing PPP and UIP
• Exchange rates are complicated because they determine the relative prices of objects traded in different markets
• PPP links exchange rates to the equilibrium in the market for G&S
• UIP links exchange rates to the equilibrium in the market for financial assets, especially bonds
Elements of Macroeconomics ▪ Johns Hopkins University
UIP and Monetary Policy
• “Dollar surges as March Fed rate hike comes into view” FT, 02/07/2017
Elements of Macroeconomics ▪ Johns Hopkins University
Monetary Policy, Interest Rates and Exchange Rates
•Market commentary about exchange rates mostly about central bank actions§ Interest rates
• A higher interest rate leads to an appreciation of the currency
•What is the nexus between exchange rates, interest rates and news?
Elements of Macroeconomics ▪ Johns Hopkins University
Comparative Statics
• Looking for the impact of one variable on another, other things equal§ What does this mean?§ Take all the other variables of the model as given
UIP: 1 + 𝑖$ = 1 + 𝑖€"@
"
•What is the impact of an increase in euro interest rate i€ on the exchange rate E$/€ taking i$ and Ee as given (unchanged)?
Elements of Macroeconomics ▪ Johns Hopkins University
Effect of 𝑖€ on the US Dollar (Other things equal)
• Assume 𝑖€ increases by 1% (other things equal)
• By how much does the dollar appreciate or depreciate against the euro?
• Increasing the euro interest rate depreciates the dollar (other things equal)
• Intuition?§ Lower demand for US bonds relative to euro bonds (other things equal)§ US dollar depreciates by 1%
Elements of Macroeconomics ▪ Johns Hopkins University
Effect of 𝑖€ on the US Dollar: Subtle Points
1 + 𝑖$ = 1 + 𝑖€𝐸𝑒
𝐸
• Today’s euro appreciation generates an expected depreciation of the euro over time which offsets the higher euro interest rate
• The “other things equal” assumption is not always appropriate§ For example, what if expected US inflation and i$ increase at the same
time?
Elements of Macroeconomics ▪ Johns Hopkins University
Exchange Rates and Expectations
• Like any asset price, exchange rates are forward looking and influenced by expectations
• UIP can help us to understand why
• Assume that we suddenly learn that the ECB is going to raise its interest rate i€ by 1% in one year: What is the impact on the exchange rate E$/€ today?
Elements of Macroeconomics ▪ Johns Hopkins University
Iterated Expectations
• Assume rational and forward-looking investors
Elements of Macroeconomics ▪ Johns Hopkins University
today in 1 year in 2 years
𝐸@ =1 + 𝑖€@
1 + 𝑖$@ 𝐸@@
𝐸 𝐸@ 𝐸@@
𝐸 =1 + 𝑖€1 + 𝑖$
𝐸@
Effects of News on Exchange Rates
• Importance of “news”§ Exchange rate is moved by changes in expectations (“news”) about
future monetary policy§ Same as for any price in financial asset markets
• Implication 1: Changes in exchange rates are not necessarily correlated with observed changes in economic fundamentals
• Implication 2: Exchange rates are volatile
Elements of Macroeconomics ▪ Johns Hopkins University
Implication 1: FFR vs Exchange Rate
Elements of Macroeconomics ▪ Johns Hopkins University
Implication 2: Exchange Rate Volatility
Elements of Macroeconomics ▪ Johns Hopkins University
News Announcements
• One way of identifying impact of change in expectations on exchange rates is to measure “news” at high frequency (intra-day data)§ Policy announcements § Data release§ Etc.
• Example: Brexit§ Vote June 23, 2016§ If E$/£ ➞ what does E ↓ mean?
Elements of Macroeconomics ▪ Johns Hopkins University
Effect of Brexit on $/£ Exchange Rate
Elements of Macroeconomics ▪ Johns Hopkins University
Exchange Rate Trading
• Currency forecasters spend a lot of time speculating about what central banks will do in the future§ “Fed watching”
• Changes in market views about future monetary policy is a primary driver of short-run fluctuations in exchange rates
• Two key factors: § News about the state of the economy, and § How central banks will respond to these developments
• Importance of central bank communication
Elements of Macroeconomics ▪ Johns Hopkins University
June 16, 2017
Elements of Macroeconomics ▪ Johns Hopkins University
Macroeconomic Policy in an Open Economy
• Aggregate Expenditure model can be extended to an open economy
• In a closed economy, we had a consumption function and investment was a function of the real interest rate
• In an open economy, in addition we will have factors affecting NX
Elements of Macroeconomics ▪ Johns Hopkins University
Key Drivers of Net Exports
• PUS Relative to PROW
§ If 𝜋US < 𝜋ROW, prices of U.S. products increase more slowly than prices of products of other countries ➞ NX will rise
• Growth Rate of GDPUS Relative to the Growth Rates of GDPROW
§ When incomes in the US rise more slowly than incomes in other countries ➞ NX will rise
• Exchange Rate Between the Dollar and Other Currencies§ As the value of the U.S. dollar rises, the foreign currency price of U.S.
products sold in other countries rises, and the dollar price of foreign products sold in the United States falls ➞ NX will fall
Elements of Macroeconomics ▪ Johns Hopkins University
Monetary and Fiscal Policy in an Open Economy
• By affecting domestic GDP, fiscal policy will also affect NX§ If your income increases, you will demand both more domestic and
foreign goods
•Monetary policy will influence the economy through two channels§ Investment and spending§ Effect on the exchange rate
• Both policies will not only affect GDP but also NX§ Manage internal and external imbalances
Elements of Macroeconomics ▪ Johns Hopkins University